Problems with IRR White Rock Services Inc. has an opportunity to make an investment with the...
Problems with IRR White Rock Services Inc. has an opportunity to make an investment with the following projected cash flows.
Year Cash Flow
0 $1,680,000
1 -3,885,000
2 2,225,021
a. Calculate the NPV at the following discount rates and plot an NPV profile for this investment: 0%, 5%, 7.5%, 10%, 15%, 20%, 22.5%, 25%, 30%.
b. What does the NPV profile tell you about this investment's IRR?
c. If the company follows the IRR decision rule and their cost of capital is 15%, should they accept or reject the opportunity? Why is it hard to make a decision on this investment based solely on the IRR rule?
d. If the company's cost of capital is 15%, should they reject or accept the investment based on its NPV?
Homework Answers
a:
| Rate | NPV |
| 0% | 20021.00 |
| 5% | -1840.36 |
| 7.50% | -8570.25 |
| 10% | -12957.85 |
| 15% | -15825.33 |
| 20% | -12346.53 |
| 22.50% | -8699.04 |
| 25% | -3986.56 |
| 30% | 8118.93 |
b: As per the profile, the IRR is between 0% and 5% or between 25% and 30%.
c: Since there are two IRRs the decision cannot be made solely on the IRR method.
d: At 15%, NPV is $ -15825.33. Hence the proposal should be rejected since NPV is negative.
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